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Differing values

Read any Western media article about history’s greatest stock market investors and a roll call of Americans will ensue. Warren Buffett or his mentor, Benjamin Graham, nearly always top the rankings, followed by more recent entrants such as David Tepper who took home $4 billion in 2009 after betting big on the survival of some of Wall Street’s largest banks.

What such lists accurately represent is the rise of American wealth and power during the twentieth century – as well as its most hubristic moments such as the global financial crisis in 2008 when fortunes were won and lost. What they do not accurately portray is the rise of Chinese wealth and power during this century.

For arguably, some of the greatest ever stock market trades are being made now by Chinese entrepreneurs by delisting their companies in the US and relisting them in China at much higher valuations. This equity arbitrage was on display again at the end of last month, when Qihoo, now renamed 360 Security Technology, was floated in Shanghai.

The anti-virus software provider originally floated on the New York Stock Exchange (NYSE) in 2011 before founder Zhou Hongyi took the company private in July 2016. At that point, it had an $9.3 billion valuation.

When 360 made its Shanghai debut on February 28, it was worth nearly Rmb380 billion ($59 billion) after investors ramped up the stock price of the shell company (previously known as Jiangnan Jiajie, an obscure elevator parts maker) prior to its backdoor listing. Zhou’s wealth instantly soared from $2.1 billion to $13.6 billion thanks to his 23% effective holding in 360.

Having rung the opening bell, Zhou said the return to the A-share market marks a new chapter for his company as it broadens its scope from internet security to national security (it can now bid for military contracts). He also declared that China should have capital markets commensurate with its economic strength.

However, the stock has failed to live up to its fanfare. It went limit-down – that is, 10% per day – on its first trading session and has continued falling since. Yet even at current levels, it is still valued at 117.5 times forecast 2018 earnings (Rmb2.9 billion), compared to the 14 times forward level it commanded when it was trading in New York.

But if Shanghai-based Focus Media’s history is anything to go by, investors who have bought 360 Security’s shares in the past week might have something to worry about. The outdoor advertising company also made its founder, Jason Jiang, a paper fortune when it delisted from NASDAQ in 2013 for about $7.4 billion and then went public on the Shenzhen bourse two years later.

But Focus Media’s A-share trading debut also marked its peak value and its share price subsequently fell from a high of Rmb20.24 to a low of Rmb7.96 in March 2017. Today, it is trading around Rmb15, giving it a $28.6 billion valuation.

In finance-focused social media chat rooms, critics were dismissive of the idea that 360’s move represents a coming of age for China’s stock markets. “The reason for the valuation difference between America and China is because Chinese people are very stupid,” was one verdict. Or as another put it, “These companies are only coming back for the money.”

But does 360’s homecoming mark the beginning of a new trend? Many US-listed Chinese firms and a few Hong Kong-listed ones went private during 2015 and 2016 after private equity investors detected a means to make a quick buck.

However, their plans were stymied when the China Securities Regulatory Commission abruptly shut the door on backdoor listings. A host of companies including Shanda Interactive, Dalian Wanda Commercial, Wuxi PharmaTech and Mindray Medical are stuck in a long queue alongside other listing hopefuls.

There have recently been signs of movement. The CSRC has proposed waivers for certain start-up companies which are currently unable to meet its listing criteria and fast-tracking IPOs across four main industries – biotech, internet, smart manufacturing and environmental protection. Wuxi PharmaTech, which was delisted in New York in a $3.3 billion buyout deal, may be one of the first beneficiaries.

One of the major reasons why so many Chinese tech firms opt for the US rather than China – including Hong Kong – is because US regulations allow them to use dual class structures, which enable founders to retain control while only holding a minority stake in their companies.

That was also the main reason why HKEx, which operates Hong Kong’s stock exchange, lost out on Alibaba’s mega IPO in 2014. Hong Kong regulators have since made amends (see WiC392). Starting late April, “new-economy companies” with dual-class share structures and even biotech firms without revenue will be allowed to go public on the Hong Kong bourse – permitting founders to retain control even if they have minority stakes.

According to Hong Kong media, smartphone maker Xiaomi and payment system operator Ant Financial, Alibaba’s sister firm, are two listing candidates that HKEx has been trying to lure.

HKEx has made clear it needs to stay competitive in the face of growing competition from mainland bourses.

There are reports too on plans for Chinese Depository Receipts (CDRs), which would trade on the Shanghai and Shenzhen bourses. According to Caixin Weekly, eight companies, including the BAT troika and Ctrip, China’s biggest online travel agency, are part of a “first wave” of firms set to be allowed to issue CDRs – which would enable local investors access to these popular stocks.

Zhou’s 360 seems to have got the regulator’s nod thanks to its national security component (see WiC388). But many tech tycoons at the ongoing Two Sessions (the annual gathering of Chinese lawmakers and advisors) said they were ready to answer their nation’s call to list at home.

“Whenever the regulations are ready, we can list straight away,” Ding Lei, NetEase’s boss told state media this week.

Issuing CDRs is likely to be a given for the big tech companies, not least because they know it is a clear policy directive. But the desire for a primary listing in Hong Kong or the US is unlikely to diminish over the short term. Company founders still want to retain hard currency offshore and maintain some independence from domestic politics.

That’s why for the moment, Chinese companies have carried on adopting a mixed approach to their listing venue.

Tencent-backed firms remain fairly wedded to Hong Kong, for example: China Literature was the most recent to list there.

One of Baidu’s crown jewels, iQiyi, China’s largest streaming service, is also working on a $1.5 billion IPO on NASDAQ.

Yet nothing illustrates the change in the CSRC’s policies more than its handling of Terry Gou’s decision to list a Foxconn unit on a mainland bourse. Foxconn Industrial Internet (FII), which makes equipment for cloud computing services and 5G solutions, said last month it applied for a listing in Shanghai.

The CSRC gave the green light on Thursday, which Xinhua suggested, illustrates the regulator’s resolve to overhaul the IPO approval system. “Foxconn will become the first overseas-funded company to go public in the A-share market,” the news agency noted, adding that FII got through the review procedure in record time.

FII will be a monster by domestic standards too. The Foxconn unit is planning to raise up to Rmb28 billion and local brokerages give it a target valuation of more than Rmb640 billion, based on the sector average of 40.9 times trailing earnings.

Some remain unimpressed. “Is our stock market so bad that we have to let an indebted Taiwanese company in,” asked an internet user. That jaundiced view may reflect something else: that tech stocks only account for 9.5% of the CSI 300 compared to nearly 50% of the Taiwan Weighted Index, although CICC said in a recent research report that new economy stocks will account for more than 50% of the A-share market within the next five years.

Retail investors have yet to learn how to play tech hardware companies with their thin margins and volatile cycles, as their Taiwanese counterparts have done. That too will almost certainly change over the coming decade.

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